STRENGTHS

Sovereign risk contained as public debt remains mainly domestic and denominated in local currency

Reduced risk of external over-indebtedness thanks to the high level of foreign exchange reserves

Gradual move up global value-chains as part of China 2025

Dynamic services sector, led by e-commerce trends

Good level of infrastructure

WEAKNESSES

High corporate indebtedness to impact growth potential

Current account surplus expected to narrow and eventually turn into deficit

Government strategy is ambiguous on arbitrating between reform and growth

Ageing population, resulting in higher public expenditure and labour costs

Environmental issues

Risk assessment

Deceleration in 2019

China’s economic growth is set to slow to 6.3% in 2019 and 6.0% in 2020. This is the result of a structural slowdown, as the economy moves away from an investment-led growth model and Beijing implements policies to reduce financial vulnerabilities. Corporate indebtedness remains the main risk to China’s long-term outlook and will continue to merit attention.

With that being said, cyclical factors are exerting additional downside pressure in the short- and medium-term. The escalation in trade tensions between the United States and China is expected to have a direct impact equivalent to at least 0.5% of GDP, although this could be as much as 1% if the United States forges ahead with threats to impose 25% tariffs on all of China’s remaining exports to the US. The indirect impact could be larger.

Household consumption, which accounts for two-thirds of GDP, has remained sluggish, owing to weaker domestic sentiment. Retail sales expanded by an average 8.6% year-on-year in the first half of 2019. An uptick in food inflation on the back of an African swine flu epidemic is not helping consumers either. Moreover, private investment slowed to 5.7% year-on-year in the first half of 2019 as business sentiment deteriorates amid lower profits.

These cyclical headwinds provide a rationale for additional policy support by the authorities. A package of measures was announced on March 2019. They include approximately 2 trillion yuan in tax cuts to lower costs for business, as well as 2 trillion yuan in infrastructure investment. The People’s Bank of China (PBOC) maintains its “prudent” stance while assuring that it will provide better credit conditions for SMEs. We expect 2-3 additional reserve requirement ratio cuts (RRR) and ample liquidity injections via open market operations in order to contain the risk of an interbank liquidity squeeze and push bank lending.

Current account surplus to deteriorate amid credit concerns

The current account surplus recovered in the first quarter of 2019, reaching 0.9% of GDP, compared with 0.4% at the end of 2018. But the devil is in the details: while exports expanded by an anaemic 0.1% year-on-year in the first half of 2019 due to the global trade tensions, imports declined -4.3% year-on-year as a result of weak domestic demand, leading to a larger trade surplus. However, as measures to stimulate the economy begin to take effect, imports are expected to rise in the second half of 2019 and into 2020. While the current account returned to a surplus in the second quarter of 2018, lower export and faster import growth will likely result in a narrowing of China’s current account, which shall nevertheless remain in surplus. With external demand remaining fragile, it is expected that current account will turn to a small deficit in 2020. Policymakers will likely intervene in foreign exchange markets to avoid overshooting depreciation expectations. A weaker yuan may help boost China’s terms of trade, but it could also ignite outflows once again, even if capital controls remain firmly in place. FDI increased in the first half of 2019, but will likely decline once headwinds to growth begin to blow.

Overall indebtedness in the Chinese economy remains extremely elevated (more than 260% of GDP). Most of the debt is owed by corporations, a large proportion of which are state-owned enterprises (SOEs). Many of these are considered “zombie” enterprises: those that are struggling with high levels of debt and overcapacity, but are kept afloat because they generate employment and output. In addition, corporate debt is difficult to assess due to the expansion of shadow banking. Moody’s estimates that shadow banking assets peaked at 87% of GDP in 2016, but fell to 67% by the end of March 2019. The figure could be higher when taking into account other types of financial intermediation by banks, including Wealth Management Products (WMPs). The government has been trying to curb this type of lending, leading to overall higher levels of loans on bank’s balance sheets. This is positive from a macro-prudential standpoint. Nonetheless, curbing shadow banking activities has had a negative impact on the financial conditions of SMEs. Finally, public debt may be higher than reported if one includes the surge in local government financing through bond issuance and local government financing vehicles (LGVFs).

Entering unchartered territory

During the 19thNational Congress of the Communist Party of China (CPC) on October 2017, all members of the Politburo Standing Committee – excluding President Xi Jinping and the Premier Li Keqiang – retired. The new line-up includes Li Zhanshu, Wang Yang, Wang Huning, Zhao Leji and Han Zheng. Xi Jinping did not announce a successor – he instead abolished presidential limits, paving the way for an extended tenure, and consolidating even more power under a series of executive bodies directly under his supervision. “Xi Jinping Thought”, a political theory, was also written into the constitution, setting a clear departure from previous party consensus, which favoured decentralisation of power.

Last update : August 2019

Payment

Cash payment is usually used for face-to-face domestic retail transactions. Due to tight capital controls imposed by the authority, an indidival can only purchase up to USD 50,000 each year. Furthermore, when a Chinese company makes an international payment in a foreign currency, the company must submit a foreign currency payment application with the local bank, along with suporting documents like sales contracts and invoices. The whole process can be quite lengthy and it is possible that the bank will reject the transaction.

Commercial Acceptance Drafts (CAD) and Bank Acceptance Drafts (BAD) are both common methods of payment for Chinese companies. These are two negotiable instruments: whereas CAD is issued by companies to entrust the payer to unconditionally pay the specified amount to the beneficiary on the date, BAD is issued by the acceptance applicant, entrusting the acceptance bank to make unconditional payment of a certain amount of money to the payee or bearer on the designated date. In pratice, BAD is regarded as safer and therefore more accepted than CAD.

Letter of credit and cheques are also used, but are less popular in China. The use of letters of credit is typically confined to big companies; and cheques are used infrequently by both individuals and companies.

SWIFT bank transfers are also among the most popular means of payment as they are rapid, secure, and supported by a developed banking network, both internationally and domestically.

Debt Collection

Amicable phase

The creditor makes phone calls and sends letters of collection to chase the debtor for payment. If debtor is responsive and acknowlegdes the debt, the two parties will negotiate payment plans to try to have payment settled. In the existence of a dispute, both parties need to come to an agreement or offer discount on debt amount.

Legal proceedings

The Chinese court system is complex. It is divided into multiple tribunals at different levels. The basic People’s Courts are at the lowest level with the County People’s Courts or Municipal People’s Courts. The basic People’s Courts have jurisdictions over most cases of first instance. Intermediate People’s Courts handle certain cases in first instance, such as major foreign-related cases, as well as appeal proceedings brought against decisions rendered by the basic People’s Courts. At the Higher level, the High People’s Courts decide on major cases in first instance. The Supreme People’s Court is at the highest level, which handles interpretation issues, and has jurisdiction over cases which have a major impact nationwide.

Fast-Track Procedure

If the debt is purely monetary, there are no other debt disputes between the creditor and the debtor, and the repayment order can be served on the debtor, the creditor can apply for a repayment order against debtor with the court. The debtor has 15 days to repay the debt after the order is issued; otherwise, he must submit a defence before the payment deadline. If debtor fails to do either, the creditor can apply for enforcement. However, if debtor’s written defence or objection is approved by the court and the ruling for terminating the debt payment order is issued, the debt payment order will be invalidated and the creditor can choose to pursue legal action. In practice, creditors do not usually use the fast-track procedure and will immediately initiate legal proceedings when the amicable phase fails.

Ordinary Procedure

Legal proceedings commence with the creditor lodging the case and submitting statement of claims with the court with corresponding jurisdiction. Once the case is accepted, court summons will be delivered to parties involved. Usually within one month, the first hearing will be arranged and the court will make a final attempt to reach a payment agreement between creditor and debtor via mediation. If no agreement can be reached, the litigation continues with several rounds of hearings, before a judgement is rendered by the court.

In theory, a first instance ruling could be rendered within six months after the case’s acceptance, but in practice, proceedings can last longer as the complexity of the case increases (for example, when there is more than one creditor, or when a foreign party is involved). In some cases, the whole process can last to one to two years. Furthermore, appeal proceedings must be terminated within three months after appeal acceptance.

Enforcement of a Legal Decision

Domestic judgments, once obtained, can be executed by, for example, seizing the debtor’s bank accounts, property, or by a transfer of rights. The creditor can apply for enforcement with the People’s Court or with an enforcement officer.

For foreign judgments, the recognition and enforcement is based on the provisions of an international treaty concluded or acceded to by both China and the foreign country or under the principle of reciprocity. In practice, enforcing foreign arbitral awards is easier than enforcing foreign court decisions in China, because over 150 countries including China have signed and ratified the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, June 10, 1958).

Another method of enforcement is the “Arrange­ment on Reciprocal Recognition and Enforcement of judgments in Civil and Commercial Matters” (REJA) between China and Hong Kong. There are similar arrangements between mainland China and Macao, as well as between mainland China and Taiwan. It provides a legal basis for Chinese courts to enforcement judgments from Hong Kong, Macao, and Taiwan. It allows creditors to use courts from Hong Kong, Macao, and Taiwan for cases in mainland China.

Insolvency Proceedings

Parties may agree debt restructuring arrangements without going to court. However, such arrangements must not jeopardize the interests of any other creditors – otherwise, they may subsequently be declared invalid in any court bankruptcy proceedings.

The 2007 Chinese enterprise bankruptcy law sets out three types of formal bankruptcy proceedings: bankruptcy, reorganization and reconciliation.

Restructuring proceedings

This can prevent a company with plentiful assets while experiencing cash flow difficulties from entering bankrptcy. Either debtor or creditor can apply with the court for Restructuring, which allows debtor to manage its properties under an administrator’s supervision. A restructuring plan should be approved by a majority of creditors in each voting class (secured, creditors, employees…) at creditor’s meetings, then sent to the court for approval within ten days from the date of adoption.

After the implementation of the restructuring plan, the administrator will supervise and submit report on debtor’s performance with the court. The administrator or debtor must file an application to the court for approval within ten days from the date of adoption.

Reconciliation

This procedure allows the company to settle its liabilities with its creditor prior to the court declaration of debtor’ s bankruptcy. The debtor directly submits a payment proposal to the court and upon receiving court’s approval on compromise payment proposal, the debtor will recover its properties and business from the administrators. The administrator will supervise debtor’s performance and report to the court. If the debtor fails to implement the compromise proposal, the court will terminate this procedure and declare debtor bankrupt as requested by the creditors.

Bankruptcy

The procedure has the purpose to liquidate an insolvent company and distribute its assets to its creditors. The bankruptcy request should be applied with the court and the request can be sent both in the name of debtor and a creditor. Once accepting the bankruptcy petition, the court will appoint an administrator from the liquidation committee and debtor will be notified within five days and is required to submit financial statement to court within 15 days. The administrator will verify the claims and distribute the assets to creditors. After the final distribution is completed, the court will receive administrator’s report and decide whether to conclude the proceedings within 15 days.